Reclassification May Hit Cable Investment Hardest

The perceived industry impact on proposed FCC reclassification of broadband transport as a common carrier service subject to six sections of the Communications Act may fall most heavily on cable operators, investor interviews and stock prices Thursday show. Cable operators largely aren’t regulated under Title II and putting their broadband services under it means the companies will be more heavily regulated, some investors and analysts said. Telcos have always had wireline operations subject to Title II, though their financial outlook is also affected by regulatory uncertainty, analysts and industry officials said.

FCC officials Thursday sought to reassure industry and investors, pointing out that because reclassification would be accompanied by forbearance from all but six sections of the Act, the status quo will remain unchanged. “The analyst community has had a range of opinions” on the subject, Bruce Gottlieb, senior counsel to Chairman Julius Genachowski, told reporters. “The center of that range as I've read it is that this is not something that’s going to have a major effect on investment.” Under Genachowski’s plan, he said in a written statement, the regulator would “take steps to give providers and their investors confidence and certainty that this renunciation of regulatory overreach will not unravel.” He noted that “heavy-handed prescriptive regulation can chill investment” and said the commission isn’t taking that approach.

Shares of cable operators fell more than the broader market Thursday and some investors linked it to concern the industry will face more regulation than in the past. Mediacom had the biggest percentage decline, losing 10 percent, with Cablevision, Comcast and Time Warner Cable all down at least 6 percent. Cable executives on Q1 conference calls opposed the proposed rules. They could impact the telecom industry across the board, some executives said.

"The so-called middle of the road approach will still lead to an investment dead end,” said Cam Cullen, vice president of deep-packet inspection vendor Procera Networks. “The damaging and protracted uncertainty that this proposal creates will dramatically slow capital investment throughout the entire Internet ecosystem.” Reclassification would “throw a monkey wrench” into an already competitive market that’s lead to new products and applications, MRV Communications CEO Noam Lotan said.

Tailoring Title II to transmission could well stir up investor fears, some industry officials said. “It injects doubt into the market,” said Vice President Joshua Seidemann of the Independent Telephone & Telecommunications Alliance. “The chairman said a number of right things to Wall Street, but they don’t resolve the outstanding question of what ultimate form the proposed regulation would take.”

The plan probably won’t affect how ISPs use network management tools, said Rick Wadsworth, director of regulatory affairs for Sandvine. He said use has been consistent since the FCC censured Comcast in 2008 -- the decision overturned last month by the U.S. Appeals Court for the D.C. Circuit. “I don’t see this as having a major impact on the way customers would use our solutions,” he said. “This is really a technical issue about how the FCC would get jurisdiction when it was decided it didn’t have it."

Network operators know the FCC’s net neutrality priorities and have for some time, said Sandvine executives and other industry officials. “We certainly didn’t see any effect of the circuit court ruling at all,” said Sandvine Executive Vice President and co-founder Tom Donnelly. “It wasn’t like people said ‘Now it’s open season.'” Most cable operators, their investors and private equity companies considering investing in systems have closely followed commission developments, so the unveiling of the plan Thursday wasn’t a surprise, said Managing Director Jeff Brandon of system broker Waller Capital. Genachowski “just basically put on a sheet of paper an agenda that’s already been pretty clear,” Brandon said. Brandon said he’s optimistic the rulemaking process “will tease all of this stuff out and ultimately what will result is something that will not be disruptive” to operators or result in higher subscriber bills.

Genachowski proposes potentially telling “cable television companies how to run their business and that has to have an impact on cash flow,” Brandon said. Net neutrality rules limiting types of network management and subjecting cable broadband to Universal Service Fund fees, as the reclassification would allow, could add to corporate costs and thus increase monthly customer bills, he said. Those eyeing cable investments are well aware of Genachowski’s net neutrality quest, so the plan won’t likely have a major impact on pending deals, Brandon said.

The specter of extra regulation affects companies like Comcast and Time Warner Cable because of their size, and smaller operators would see less impact, said Chairman Joe Duggan of broker DH Capital. Values of smaller cable systems haven’t suffered, he said. “If you're a private equity guy looking to do something in a more rural market, I'm not sure that they're very concerned.” Those pursuing system deals may be given pause by reclassification plans, said Chris Marangi, who helps manage money for media investor Gabelli & Co., with $28 billion in assets under management March 31. “This is all going to get litigated, it’s all going to go to the Supreme Court. It throws an enormous amount of uncertainty into the market -- it hampers multiples and deals in this area."

Word of reclassification “was a negative surprise,” said analyst John Krause of Thrivent Financial for Lutherans, with $67 billion under management at year’s end. “I do think this is a very blunt action that creates more uncertainty overall,” he said. “Even if they do these forbearances … the forbearance actions could come and go and that’s a problem.” Since carriers have been planning for net neutrality in setting budgets, the plan may not change spending much for now, Krause said. For cable, “it’s clearly a negative for them if they get roped into this situation,” he continued. “It’s a more onerous mandate or oversight from the FCC if you're classified as Title II."

Reclassification could hurt capital investments among broadband providers, Sanford Bernstein analyst Craig Moffett wrote investors late Wednesday after Genachowski indicated the stance he'd take (CD May 6 p1). “This development is an unequivocal negative development for almost all of our coverage universe,” Moffett wrote: “Most significantly for the cable operators and Verizon.” The only potential winners among content distributors and telcos are DirecTV and Dish Network, for whom incremental broadband regulation would dramatically cut the risk of competitive foreclosure in the video business, he said. (See Notebook in this issue.)

Telcos and cable companies won’t like this and they'll work together to fight the move, likely in courts, predicted UBS analyst John Hodulik. Their main weapon may be that under Chairman Kevin Martin, the FCC reclassified these services under Title I and not much has changed since then, he said. The agency is expected to be “as industry-friendly as possible,” to allow carriers to offer usage-based billing and provide content distribution and other managed services, Hodulik said. He expects the commission to distinguish between wired and wireless networks and maintain a “light touch” approach to wireless data.